Optimizing Life and Disability Benefits in Employer Plans
Not surprisingly, recent surveys indicate that the major employer objective vis-à-vis benefit plans is to control costs. The biggest cost driver is, of course, health insurance, followed by dental plans. Because Life and Disability cost only a fraction of other benefits they are often overlooked in the renewal planning process. However, with good plan design, employers can offer high quality benefits at reasonable and fairly predictable costs.
In the broadest sense, the purpose of employer sponsored health and welfare benefit programs is to protect participants and their families from the financial loss that can result from illness, injury or death. In order to attract, retain, reward and protect the security of their employees, employers establish programs such as health and dental coverage, basic and voluntary life insurance, long and short term disability benefits, long term care, vision care and other arrangements designed to protect and preserve income. Some of these plans are more attention getting than others - employees are particularly attracted to dental benefits, for example. In this "white paper" we will review two of the basic building blocks of a sound benefit program: Life and Disability insurance.
Group Term Life Insurance is generally sold in conjunction with Accidental Death and Dismemberment (AD&D) coverage. Some features of Life and AD&D plans are:
- Premiums are tax deductible to the business (except for coverage provided to sole proprietors, partners, S Corp shareholders) and for amounts of coverage up to $50,000, generally are not taxable to the insured employee.
- Life insurance benefits are received income tax free by the beneficiary.
- Although a small percentage of plans offer "flat amounts" of coverage and some offer benefits based on the employee's job classification, the most prevalent design is some multiple of the participants' earnings.
- A plan may discriminate in favor of highly paid or key employees, although such an arrangement could result in the loss of the tax exemption for the 1st $50,000 of coverage for the key employees.
- The multiple of earnings approach (1, 2 or 3 times annual income, for example) is the most popular design because it is non-discriminatory and has the advantage of maintaining a consistent level of coverage not eroded by inflation.
- Business owners and managers and high net worth individuals should consult with their tax advisors about assigning their group life benefits to a trust for estate planning purposes
A fast growing feature of group life plans is a "Voluntary Benefit" feature. Under this approach the employer provides a basic plan (say 1 or 2 times earnings) and the plan allows employees to buy additional coverage to suit their needs. This is paid for strictly by the employee, and the employer merely facilitates it through the payroll system. This gives the employee the benefits of convenience and sometimes additional "guaranteed issue" coverage (no medical questions) which might be unobtainable by other means, while enabling the employer the ability to offer additional benefits at no additional cost to the company.
Short Term Disability (STD) and Long Term Disability (LTD) benefits are usually written in tandem. STD is characterized by a short elimination period (7 days, for example) during which a person is disabled and benefits are not payable, and then a benefit payment duration ranging up to six months. LTD benefits generally begin when the STD benefits end, and are generally payable to a person's normal retirement age.
STD is a benefit designed to provide a bridge during which a person who is suffering from a relatively minor disability may have his/her paycheck partially replaced. Coverage is generally written on a "non-occupational" basis so that only disabilities occurring off the job are covered. A typical income replacement ratio is 60% of pre-disability earnings. Larger employers often find that STD is a benefit that may be easily "self-insured" because losses can tend to be predictable and would not be catastrophic. Even larger employers however, usually involve an insurance company or other third party claims administrator in order to insulate them and their employees from the responsibility to make judgments about eligibility for benefits.
LTD, on the other hand, does cover potentially catastrophic claims which may last many years. It is rarely self-funded. The major thrust of LTD coverage, surprisingly, is not the 20 or 30 year claim, even though those do happen. It offers coverage for extended periods of recuperation from accidents or such illnesses as heart attack, stroke or cancer. It is said that, in many respects, a disabled wage earner can be more devastating to a family then a deceased wage earner, because the disabled individual is an emotional and financial expense. LTD can mitigate the financial stress.
LTD is often written so that the employer pays the entire cost of the plan. When done this way, any benefits payable by the plan would be fully taxable to the disabled individual. In a typical plan providing for a 60% of pay replacement ratio, a taxable benefit would result in a substantial loss of income. There are two ways to design a plan such that the individual pays no tax on benefits received. The first, called a "gross up" plan, has the employer add the cost of the premium to every individual's W-2 at the end of each year. In that way, the employer pays the premium and the employee pays the tax on the premium, which will result in a tax-free benefit. Another alternative, called "tax choice," offers the participant the choice of whether to have the premium added to the W-2 and thereby pay the tax. There are advantages to both arrangements. Some insurance carriers add a small percentage to the premium rate for a gross up or tax choice arrangement.
Disability benefits, like life insurance benefits, may be written so that the employer pays for part of the benefit and the employees voluntarily elect to buy additional amounts or additional coverages. Long Term Care is another disability related benefit that has become increasingly popular as a partially employer funded and partially employee funded benefit, although it is not as prevalent as the core benefits of STD and LTD.
Healthcare reform and rising medical costs continue to dominate national headlines, and, understandably, demand the attention of employers. While grappling with the healthcare cost problem each year, employers often look for some rare positive news to share with their employees. They are usually quite surprised to find there is an attractive suite of benefits that can be both high quality and reasonably priced.
The materials created through August 2011 are when the professionals of Summit Financial were with Ogilvie Security Advisors Corp. The professionals of Summit Financial have not been with Ogilvie Security Advisors Corp. since August 31, 2011 and have no further affiliation with that organization.